BIS Report: Watch out for a credit bust in Emerging Markets

The Bank for International Settlements (BIS) has published its latest report yesterday and warned emerging economies, more specifically Brazil and India, about a more accentuated decline in economic growth as the western crisis unfolds. According to the report, such a boom-and-bust cycle might have severe global repercussions, not least due to the increased weight of emerging markets in the world economy and in investment portfolios. It also warned the central banks of emerging economies to pay more attention to their domestic policies as they may be risking the rise of financial imbalances similar to those seen in advanced economies in the years immediately preceding the crisis.

Main highlights:

“… debt-to-GDP ratios have continued to rise in many other economies (see chart below, top panel). Credit has burgeoned in several major emerging market economies in recent years. For instance, real credit grew by almost 20% annually over the last three years in China, although it has been slowing recently. Real credit in Turkey, Argentina, Indonesia and Brazil has also far outpaced GDP, and credit growth has even accelerated during the past three years.

… But credit growth that is significantly above its long-term trend, opening up a so-called credit gap, often foreshadows a financial crisis. At present, several (but not all) of the countries experiencing rapid credit growth have credit gaps in excess of 6%, levels that in the past have often presaged serious financial distress (see chart below, bottom panel).

Asset prices too look increasingly frothy in many emerging economies (see chart). In some important local Brazilian markets, real estate prices have almost doubled since the onset of the subprime crisis. Appreciation of real estate assets in China is even more pronounced, with land prices in Beijing and Shanghai increasing almost fivefold since 2004.

… Measures of debt service cost also suggest that high debt levels could be a problem. The fraction of GDP that households and firms in Brazil, China, India and Turkey are allocating to debt service stands at its highest level since the late 1990s, or close to it.”